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ECB kicks off corporate bond buying

The European Central Bank (ECB) has formally started its corporate sector purchase program (CSPP), a move announced by President Mario Draghi in March. The program, along with other measures such as ultra-cheap long-term loans and government bond-buying, aims to kickstart the euro zone economy and lift inflation to the bank's target of 2 percent.

As part of its plan, the ECB will buy euro-denominated investment grade bonds issued by companies in the euro area. The bank has already started buying five-year utility bonds in the secondary market, according to Reuters.

Some of the companies that are most eligible for bonds since they are non-financial and have the highest investment grade include EDF energy, AbInBev, Telefonica, Volkswagen, T-Mobile and Enel. Sectors that are most likely to benefit from this program include utilities, consumer goods and telecoms, according to analysts.

"The way we think about CSPPs is it is a step sideways not a step forward. It is a policy damage limitation because last year the credit market wasn't healthy under this absurdly low interest rate environment," Barnaby Martin, Managing Director of European Credit Strategy at BofA Merrill Lynch told CNBC. He added that the success of this policy will be seen in various stages and there is a huge reputational risk since the details of the bonds will be published regularly.


How does it work?

The program will be carried out by six central national central banks. These include the central banks of Belgium, Germany, Spain, France, Italy and Finland. While each central bank will be responsible for purchases from issuers in a particular part of the euro area, the ECB on the whole will coordinate the purchases.

"The idea to include investment-grade corporates is a good one because the ECB has always sought to improve the transmission mechanism into the real economy," Vincent Juvyns, Global Markets Strategist at JP Morgan Asset Management told CNBC via email, adding that with the CSPP the money is going right into the pocket of those who need it: European businesses.

According to the ECB, the bonds must have a minimum remaining maturity of six months and a maximum remaining maturity of 30 years at the time of purchase. However, a research report from KBC bank says that more 55 percent of the outstanding bonds mature between now and the end 2021, 74 percent of the bonds mature between now and 2023 and only about 9 percent of the bonds matures more than 10 years from now. So the average maturity of the CSPP portfolio will most likely be less than 5 years.


But corporate bond markets in Europe welcomed the move. JP Morgan's Juvyns says from its analysis of bond issuance in Europe, it has seen a pick-up since the CSPP was announced.

"In terms of the kind of scale and speed the ECB could accomplish with CSPP, if you look at the overall investment-grade credit market in Europe, it is 1.6 trillion euros. If you exclude banks accounting for 500 billion euros and exclude subordinated debt and you exclude non-euro zone corporates based on what is publicly available on the ECB's website, you end up with a market of approximately €580 billion and out of that the ECB has said that they could go up to 70 percent in any given issue,"

The ECB has further specified that the bonds can be issued by any company incorporated in the euro area, even if its ultimate parent company is not based in the euro zone region. However, there are caveats to that. The issuer of the bond must not be a credit institution, does not have any parent undertaking which is a credit institution and is not an asset management vehicle.

Before issuing bonds, the eligible company will undergo a credit risk and due diligence procedures, conducted by the Eurosystem.


Where to find it?

The bonds will be available in both the primary and secondary markets by the six central banks across the euro zone. While it is still not clear how much the ECB intends to buy at this stage, market analysts have said it is likely to be €5 to maximum €10 billion per month, depending on the level of new issuances.

The ECB will publish the volume of CSPP holdings on a weekly and monthly basis and a breakdown of primary and secondary market purchases will also be published monthly. The first list will be published on Monday, 18 July and will be refreshed every Monday thereafter.

"We have seen a change in the market's behavior since the ECB first announced its corporate bond purchase programme in March," Mike Della Vedova, manager of the T.Rowe Price European High Yield Bond Fund told CNBC via email. He further added that after the ECB's announcement, there was a pickup in credit demand and the rally gathered pace as it became clearer that the central bank's remit is wide.


However not all analysts agree. Some analysts are of the view that this move is risky for the ECB and short term spreads are likely to tighten.

"There are risks associated with the new program. Companies too small or highly-leveraged to issue high yield bonds under normal circumstances may be able to do so in this environment, and investment grade companies may be tempted to over-extend themselves," Jon Jonsson, manager of the Neuberger Berman Global Bond Fund told CNBC via email.

He explained that while this has been the case in every bull market, the extent of the ECB's purchases and the long maturities it is prepared to buy will make the euro investment grade corporate universe look more and more like the core government bond market.


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